04 July 2013

China Tax: Unveiling the International Secondment Arrangement

Over the years, it has been common practice for a multinational company ("Home Entity") to dispatch expatriate employees ("Secondees") to its affiliated enterprise in China ("Host Entity") to hold senior management or other technical positions. Usually, the Home Entity and the Secondee will retain the employment relationship. The Home Entity will pay the salary and social security contribution for the Secondee in the home country, and will be reimbursed by the Host Entity. A Chinese tax clearance certificate is usually required when the Host Entity makes the reimbursement payment, so the Chinese tax authority needs to determine whether the Home Entity constitutes an establishment/place of business ("taxable presence") or a permanent establishment ("PE") under the relevant tax treaty and thus be liable to Enterprise Income Tax ("EIT") consequence in China. The tax authorities and the Host Entity may have different views due to the ambiguity of tax regulations in the assessment of taxable presence or PE for cross-border secondment arrangements. As a result, the Host Entity often has difficulty in obtaining the tax clearance certificate and cannot remit the payment to its overseas Home Entity.The situation is likely to change from June 1, 2013.

On April 19, 2013, the State Administration of Taxation(SAT) issued the Announcement on Issues Concerning Enterprise Income Tax on Services Provided by Non-resident Enterprises through Seconding Personnel to China ("Announcement 19"), Which provides clearer guidance over the criteria for determining whether the Home Entity under a secondment arrangement will constitute a taxable presence or a PE in China. Announcement 19 is based on tax circular Guoshuifa [2010] No.75 (Circular 75) and is a further development in respect of the PE assessment for international secondment in China. Where the Home Entity constitutes a taxable presence or a PE in China, (apart from Individual Income Tax (IIT) which usually apply to the Secondees) EIT will be imposed on the Home Entity. This new policy will significantly impact the tax cost of Home Entities and the pattern of structuring international assignments.

Based on the salient points of Circular 75 and the latest Announcement 19, we summarize below the issues concerning the assessment of taxable presence or PE under secondment arrangements.

Criteria determining the constitution of taxable presence or PE in China

According to Circular 75, if at the request of its PRC subsidiary, the overseas parent company dispatches personnel to work for the subsidiary, and such personnel enter into formal employment with the PRC subsidiary which has command over their work, and the work responsibilities and risks are entirely assumed by the subsidiary, instead of the parent company, then the activities of such personnel shall not trigger a taxable presence or a PE of the parent company in China. In this case, the fees paid, directly by the PRC subsidiary or indirectly through the parent company to such personnel, shall be deemed payroll expenses paid to the PRC subsidiary's employees.

Moreover, Announcement 19 clearly states that, where the Home Entity dispatches personnel to render service in China, if the Home Entity bears all or part of the responsibilities and risks in relation to the work of the Secondees, and normally reviews and evaluates the job performance of the Secondees, the Home Entity shall be deemed as having a taxable presence in China. If the Home Entity is a tax resident of a country/region that has entered into tax treaty with China, such establishment and place of business may create a PE in China if the criteria of PE have been met under the applicable treaty provisions, for instance, the Secondees' stay in China has exceeded 183 days or 6 months in any consecutive 12 month period.

When doing the above assessment, the following factors shall be taken into consideration:

  • The Host Entity makes payments to the Home Entity in the nature of management fees or service fees
  • Payments from the Host Entity to the Home Entity exceed the Secondee's salaries, bonus, social security contributions, and other expenses as advanced by the Home Entity
  • Not all related expenses reimbursed by the Host Entity are paid to the Secondees, instead, the Home Entity retains a portion of such payments
  • IT has not been reported and paid based on the full amount of the Secondee's salaries and
  • The Home Entity is the decision maker in terms of the number, the qualification, the remuneration and the working locations of the Secondees in China.

Generally speaking, if one of the above factors is met and the work of Secondees has substantial connection with the Home Entity, the Home Entity is likely to be assessed as having a taxable presence or a PE in China.

In addition, Announcement 19 stipulates that, if the Home Entity constitutes a taxable presence or a PE in China, the Host Entity and the Home Entity shall perform tax registration or record-filing with the tax authorities, and file EIT based on the actual income generated in China, if it is not feasible to accurately calculate the taxable income, the tax authority is empowered to deem the taxable income in accordance with relevant regulations.

KWM Observation

1. With the release of Announcement 19, it is expected that the tax authorities will strengthen their oversight of secondments between multinationals and their subsidiaries in China. It is suggested that enterprises review their existing secondment arrangements and assess the underlying tax risks. The bright side of Announcement 19 is that it provides greater certainty about the tax treatment of secondments, and will facilitate smoother tax clearance when Host Entities make reimbursement payments overseas.

2. Where PRC IIT is paid on the full amount of the Secondee's salaries, then even if the Home Entity bears part or all of the expenses, it is not likely to create a taxable presence or a PE for the Home Entity because it does not bear the Secondee's salary and does not derive a profit through the secondment arrangement.

3. This Announcement clarifies that where the Home Entity assigns its expatriate employees to China solely to exercise its shareholders' rights and safeguard the shareholders' interest, the Home Entity will not be deemed to have a taxable presence or a PE in China.

4. Enterprises should establish the factual background to substantiate the connection between the work of Secondees and the Host Entity. It is of vital importance to put in place proper documentation about the work reporting requirements and evaluation mechanism of job performance, The documentation should include: (1) relevant contracts of employment and/or secondment; (2) Secondee's job description for the Home Entity or the Host Entity, including responsibilities, role, performance indicators and assumption of risk of the Secondees; (3) the terms governing payments to be made by the Host Entity to the Home Entity and accounting treatment, and the IIT filing and payment records of the Secondees in China; and (4) information about whether the Host Entity treats a Secondees' expenses by way of offsetting inter-company accounts, waiver of creditor's rights, related party transactions or other means, in lieu of reimbursement.

Announcement 19 becomes effective from June 1, 2013, and also applies to existing secondments where the tax treatment has not been confirmed or the reimbursement has not been made. It is suggested that enterprises shall assess the tax implications of Announcement 19 on their current secondments and, where needed consider restructuring the international assignment arrangement and put in place proper documentation to safeguard the parent company's tax position and mitigate PRC tax risks.

(This article was originally written in Chinese, and the English version is a translation.)

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